Morning Report: The Fed hikes aggressively

Vital Statistics:

S&P futures3,699-94.25
Oil (WTI)113.21-2.64
10 year government bond yield 3.43%
30 year fixed rate mortgage 6.03%

Stocks are lower this morning as markets digest the Fed’s move yesterday. Bonds and MBS are down.

The Fed raised the Fed Funds rate 75 basis points yesterday. This was the biggest increase since 1994. We got a new set of projections as well, with the Fed raising its inflation and unemployment forecasts and cutting GDP growth forecasts. The dot plot moved upward pretty dramatically. You can see the June versus March plots below:

The central tendency in March was for a Fed Funds rate between 1.75% and 2% by the end of the year. That forecast is now 3.25% – 3.5%. The forecast for 2022 GDP was lowered from 2.8% to 1.7%, while the forecast for unemployment was moved up from 3.5% to 3.7% and the forecast for inflation was increased to 5.2% from 4.3%. The core inflation forecast (ex-food and energy) was bumped up slightly from 4,1% to 4.3%.

Jerome Powell said the central bank focused a lot on the University of Michigan sentiment index, especially the part about inflationary expectations. The median expectation for inflation was 5.4%, but the mean was 7.4%. That is a big concern for the Fed. The fear is that we get a wage-price spiral, where prices rise, workers demand higher compensation, which increases prices and drives further inflation. The big question concerns whether the Fed is chasing oil prices. Since the Fed has no control over commodity prices, it really should focus on core inflation. That said, its mandate is to manage headline inflation, so it may be forced to overreact to rising food and energy prices.

With the Atlanta Fed predicting 0% GDP growth this quarter, and the lousy retail sales print yesterday, we might already be in a recession. And if we are, we might be getting to the point where bad economic news is considered good news since investors will assume economic weakness will take the top off inflation and allow the Fed to take a breather on rate hikes. The minutes to the June meeting will be interesting to read.

So far, the yield curve has steepened in response to the meeting, with 2s / 10s trading at 14 basis points. Corporate credit spreads are behaving as well, so we aren’t seeing indications that economic weakness is spilling over into the financial sector, at least not yet.

Housing starts disappointed again, as rising home prices, mortgage rates, and materials prices make new houses expensive. Starts fell 14% MOM and 4% YOY to a seasonally-adjusted annualized pace of 1.55 million. Building Permits came in flat YOY at 1.7 million.

The NAHB / Wells Fargo Housing Market Index (which measures builder sentiment) fell to the lowest level since June of 2020. This is the sixth consecutive monthly decline. Building materials costs are up 19% YOY, except for lumber.

Housing remains a weak part of the economy, however it usually leads the economy out of a recession. If we get some relief on inflation and rising interest rates, perhaps the housing sector will get some legs later this year or next.

Morning Report: Markets await the Fed

Vital Statistics:

S&P futures3,77439.25
Oil (WTI)118.21-0.64
10 year government bond yield 3.37%
30 year fixed rate mortgage 6.06%

Stocks are higher this morning as we await the FOMC decision at 2:00 pm. Bonds and MBS are up.

The FOMC decision will be released at 2:00 pm today. The market is predicting a 75 basis point increase in the Fed Funds rate. One week ago, the market was certain that the Fed would hike 50 basis points, so we have had a pretty sizeable jump in expectations in a short period of time. We will also get a fresh set of economic projections as well as a new dot plot.

Volatility in global bond markets has made predicting the reaction to the Fed decision pretty much a fool’s errand. I suspect the dot plot will be the main thing traders focus on, with an eye to predicting whether the Fed moves 50 or 75 in June. Note that European sovereign yields are down hard this morning as the ECB has called an emergency meeting to discuss volatility.

Retail sales fell 0.3% in May, according to the Census Bureau. This was below consensus. April’s numbers were revised downward as well. Ex-vehicles and gas, retail sales rose 0.1%. Motor vehicles were a big drag on the numbers. That said, it looks like consumers are beginning to pull in their horns, which can be a either a blessing or a curse for the Fed. If the drop in spending cools off inflation, then we have a better chance for a soft landing. If not, then we are looking at stagflation all over again.

Mortgage applications rose 6.6% last week as purchases rose 8% and refis rose 4%. This was the first increase in apps in 5 weeks. “Mortgage rates followed Treasury yields up in response to higher-than-expected inflation and anticipation that the Federal Reserve will need to raise rates at a faster pace,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Despite the increase in rates, application activity rebounded following the Memorial Day holiday week but remained 0.29 percent below pre-holiday levels. With mortgage rates well above 5 percent, refinance activity continues to run more than 70 percent lower than last year.”

Separately, Wells Fargo’s CFO said at a conference yesterday that he expected Q2 mortgage banking income to be down about 50% from Q1.

The increase in mortgage rates this year has been the biggest since 1981. Between the increase in home prices and the rise in rates, the typical principal and interest portion of a mortgage is up big as well. This is cooling down the housing market, and Moody’s is predicting that home price appreciation will be flat over the next year, and some markets might see a drop in prices.

Morning Report: The market makes a dramatic shift in interest rate forecasts

Vital Statistics:

S&P futures3,76919.25
Oil (WTI)123.012.24
10 year government bond yield 3.34%
30 year fixed rate mortgage 5.94%

Stocks are higher this morning after yesterday’s bloodbath. Bonds and MBS are up small.

Yesterday’s market sell-off took the S&P 500 into bear market territory, which is defined as 20% from the peak. What caused the stock market to sell off so dramatically? The answer is that the markets reassessed their forecast for this week’s FOMC meeting. The Fed Funds futures went from forecasting a 50 basis point tomorrow to a 75 basis point hike. Take a look at the Fed Funds futures chart below:

Last week, the Fed Funds futures were predicting a 96% chance for a 50 basis point hike. They are now predicting a 94% chance of a 75 basis point hike. This is all in reaction to the overly-hot CPI number on Friday.

One other market observation is this reassessment of Fed policy has flattened the yield curve. The yield curve is basically a plot of the interest rate at different maturities. Typically, the yield curve slopes upwards, which means that investors require a higher interest rate for longer maturities than shorter ones. That is no longer the case in any meaningful way. The 2 year bond yield is 3.33%, while the 10 year is 3.35%. The difference is a mere 2 basis points. A year ago, that difference was 2% or 200 basis points. The black line in the chart below is what the curve looked like a year ago. The blue line is what it looks like today.

If long term rates fall below short term rates (in other words, a yield curve inversion), that often forecasts a recession. Note that the shape of the yield curve means a lot less in a QE world, but historically that has been a decent economic signal. That is what stocks are reacting to.

Inflation at the wholesale level rose 0.8% MOM in May, according to BLS. On an annual basis, prices rose 10.8%. Ex-food and energy, prices rose 0.5% MOM and 6.8% YOY. These numbers were a tough below Street expectations, but probably won’t make a difference as far as Fed policy is concerned.

Small business optimism is under pressure, according to the NFIB small Business Optimism Survey. Expectations about the future are downright awful, and the expectations index is at a record low. This is being driven by inflation, a tight labor market, and continued supply chain issues. The thick line in the chart below shows whether businesses think this is a good time to expand. The thin line shows expectations for the future.

Morning Report: Markets still reacting to Friday’s inflation data

Vital Statistics:

S&P futures3,809-90.25
Oil (WTI)118.91-1.84
10 year government bond yield 3.27%
30 year fixed rate mortgage 5.66%

Stocks are lower this morning as rates continue to rise in the aftermath of Friday’s CPI report. Bonds and MBS are down. With the stock market hovering just above 3,800 we are officially in a bear market. Having fun yet?

The Fed is almost assuredly going to increase the Fed Funds rate by 50 basis points at its meeting this week. Traders will parse the language for the degree of hawkishness, but I think markets are pretty much factoring in 50 basis points in June, July, and September. That is a lot of tightening in the face of a weak economy. The Atlanta Fed’s GDP Now index has Q2 growth coming in at 0.9%. Don’t forget Q1 was highly negative, so if Q2 ends up being negative, we will officially be in a recession.

Since the unemployment rate is so low, an official recession might not make a difference to the Fed. Their dual mandate is for unemployment and inflation, not growth and inflation.

In other data this week, we will get the producer price index tomorrow, housing starts, retail sales and leading indicators. So a pretty busy week, but the Fed will dominate the data.

About the only good news these days is that house prices are rising and making homeowners wealthier. In the first quarter, home equity rose 32.2%, according to Corelogic. Patrick Dodd, CEO of Corelogic said: “Price growth is the key ingredient for the creation of home equity wealth. Home prices were up by 20% in March compared to one year earlier in CoreLogic’s national Home Price Index. This has led to the largest one-year gain in average home equity wealth for owners and is expected to spur a record amount of home-improvement spending this year.” Over the past year, the average home gained $64k in home equity.

Got credit card debt? Debt-consolidation cash-out refis are a good way to lower your rate.

Morning Report: Bad news on inflation

Vital Statistics:

S&P futures3,965-62.25
Oil (WTI)121.41-0.14
10 year government bond yield 3.10%
30 year fixed rate mortgage 5.53%

Stocks are lower this morning after the CPI report. Bonds and MBS are down.

Inflation at the consumer level rose 1% month-over-month and 8.6% on an annual basis. This is a 40 year high for the index. Ex-food and energy, the index rose 0.6% on a MOM basis and 6% year-over-year. These numbers were higher than Street expectations.

The worrisome part of the CPI reading is that the month-over-month numbers are not falling. The April reading looks like an outlier, as we had a dip in energy prices that month, but it is hard to argue that price appreciation is peaking.

The food at home index (i.e. supermarket prices) rose 11.9% YOY, which was the largest increase since 1979. Food away from home (restaurant prices) rose 7.4%, however making apples-to-apples comparisons for restaurants is tough since portion sizes are hard to measure.

Ex-food and energy, shelter (i.e. home prices) rose 5.5%, which was the biggest increase since 1991. Rising home prices tend to affect the index with a 12-18 month lag, so these numbers would reflect late 2020 / early 2021 home price appreciation numbers. Since we have been seeing home prices rise in the high teens over the past few quarters, the index will begin to reflect this in the numbers as we move through this year and next.

Overall, this report didn’t show what the market was hoping to see – any indication that inflation is beginning to moderate. The Fed is probably going to hike 50 basis points at the meeting next week, and in July.

Consumers are in a downright awful mood, according to the University of Michigan Consumer Sentiment Index. The index declined 14% compared to May and is down 41% on a year-over-year basis. To put things into perspective, consumer sentiment is at the lows experienced during the 1980-1982 recessions, which at the time was the worst since the Great Depression.

Morning Report: The ECB paves the way for rate hikes

Vital Statistics:

S&P futures4,100-13.25
Oil (WTI)121.41-0.64
10 year government bond yield 3.05%
30 year fixed rate mortgage 5.51%

Stocks are lower this morning as the ECB prepares to hike rates. Bonds and MBS are down.

The ECB has ended quantitative easing and has paved the way for a 25 basis point hike in rates. Europe has been in a negative rate environment for a long time, so the adjustment will be worth watching. Since global bond yields generally correlate, a rise in European yields will push up US yields as well. That said, the US Treasury is still one of the highest-yielding sovereigns on the planet.

Stocks and bonds sold off on the announcement, with the 10 year ticking towards 3.05%.

Rising rates have decreased mortgage credit, according to the MBA. Interestingly, we are back at post-crisis levels, although much of it is driven by higher rates. “The index remains more than 30 percent below pre-pandemic levels, as credit tightening has occurred in recent months around refinance loan programs,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Last month’s tightening was most notable in the government and jumbo segments of the mortgage market. The decrease in government credit was driven mainly by a reduction in streamline refinance programs, as mortgage rates increased sharply through May, slowing refinance activity. Jumbo credit availability, which was starting to see a more meaningful recovery from 2020’s pullback, declined after three months of expansion.”

2.71 million mortgages were originated in the first quarter, according to data from ATTOM. This is down 18% from the fourth quarter and 32% from a year ago. “The drop-off in Q1 refinancing activity is no surprise with mortgage rates rising as rapidly as they have,” said Rick Sharga, executive vice president of market intelligence at ATTOM. “But many forecasts expected purchase loans to remain strong in 2022, and even increase in both the number of loans originated and the dollar volume of those loans. The weakness in purchase loan activity shows just how much of an impact the combination of escalating home prices and rising interest rates have had on borrower activity this year.”

While the percentage decline is grabbing attention, compared to post-bubble numbers current production is still pretty strong.

Initial Jobless Claims ticked up to 229,000 last week. These are still historically very low numbers, but we are beginning to see some layoffs happen.

Morning Report: The World Bank cuts its global growth forecast.

Vital Statistics:

S&P futures4,138-31.25
Oil (WTI)120.410.64
10 year government bond yield 3.01%
30 year fixed rate mortgage 5.50%

Stocks are lower this morning after the World Bank cut its global growth outlook. Bonds and MBS are down small.

The World Bank cut its 2022 global growth forecast from 4.1% to 2.9%. This is a pretty sizeable slowdown from the 5.7% we experienced last year. The war in Ukraine, supply chain issues, and lockdowns in China are the big drivers of the downgrade. Stagflation is a risk as the economic environment looks similar to the 1970s, with a combination of supply shocks and a prolonged period of highly loose monetary and fiscal policy. The World Bank expects global growth to slow even further in 2023 to 2.3%.

This slowdown in growth will probably put pressure on the Fed to moderate its path of consecutive 50 basis point hikes in the Fed Funds rate. The Fed will be data-dependent, however the drop in new home sales is worrisome since housing has typically been a big driver of economic performance.

Consumer attitudes are pessimistic, according to a Wall Street Journal / NORC poll. 83% of consumers said that the economy was “poor” or “not so good.” A third said they were not satisfied with their financial situation, while only about a quarter expected to see an increase in their standard of living going forward. That said, the labor market is still strong, with 2/3 of respondents saying they could get a new job with similar salaries and benefits. Overall, these consumer sentiment surveys are often negatively correlated with gas prices. When prices at the pump are high, consumers get discouraged.

Mortgage Applications fell 6.5% last week as purchases fell 7% and refis fell 6%. “While rates were still lower than they were four weeks ago, they remained high enough to still suppress refinance activity,” Kan said. “Only government refinances saw a slight increase last week. The purchase market has suffered from persistently low housing inventory and the jump in mortgage rates over the past two months. These worsening affordability challenges have been particularly hard on prospective first-time buyers.” You can see below that the index eclipsed the lows of 2018. The index itself is at a 22 year low.

Home Prices rose 20.9% in April, according to the CoreLogic Home Price Index. They are expected to rise another 5.6% over the next year. It looks like CoreLogic bumped up their forecast which had been in the low single digits previously. Rising rates have driven buyer urgency this spring, as 70% of homes sold above the asking price.

“The record growth in home prices is a result of a scarcity of for-sale inventory coupled with eager buyers who want to purchase before mortgage rates go higher. Buyers who closed on their home in April had locked in their mortgage rate in February or March, when rates were lower than today. With 30-year fixed mortgage rates much higher now, we expect to see waning buyer activity because of eroding affordability. As a consequence, our forecast projects slowing price growth over the coming year.”

Morning Report: Tappable equity hits a record

Vital Statistics:

S&P futures4,078-41.25
Oil (WTI)117.95-0.64
10 year government bond yield 3.00%
30 year fixed rate mortgage 5.50%

Stocks are lower this morning after another profit warning from bellwether retailer Target. Bonds and MBS are down.

Target made a profit warning this morning saying that it will need to discount some inventory in order to move it.

“We’ve had some additional time after earnings to really evaluate the overall operating environment,” said Target Chief Executive Brian Cornell in an interview. That includes watching consumer behavior as they face high rates of inflation, he said, and seeing many other retailers talk about high inventory levels during their earnings presentations. “We have to be decisive and get out in front of this to make sure this doesn’t linger through the back half of the year,” he said.

Consumption is 70% of the economy, so warnings from retailers are a red flag. The Atlanta Fed’s GDP Now model has Q2 GDP coming in at 1.3%, which is pretty lousy given that GDP contracted in the first quarter.

That said, we are starting to see some moderation in inflationary indicators. Shipping rates are down 33% from their peaks in fall of 2021. Fertilizer prices are beginning to drop as well.

Tappable equity (in other words, home equity above 20%) rose $1.2 trillion in the first quarter of 2022 as home price appreciation accelerated. This is a record gain. Total tappable equity sits at $11 trillion, or about $207,000 per mortgaged property. This is more than 2x the amount of tappable equity at the peak of the US residential real estate bubble of the mid ’00s.

This increase in tappable equity creates opportunities for cash-out refinances. That said, the vast majority of this equity is held by high-credit borrowers with very low rates. They don’t have much high-rate credit card debt to refinance and would probably prefer to take out a HELOC if they want to take out any equity.

Morning Report: Loretta Mester sees 50 basis point hikes all summer long.

Vital Statistics:

S&P futures4,144.25
Oil (WTI)119.550.64
10 year government bond yield 2.98%
30 year fixed rate mortgage 5.42%

Stocks are higher this morning as China’s COVID crisis seems to be ending. Bonds and MBS are down.

The week after the jobs report is generally data-light, and we will also have no Fed-Speak as this is the quiet period ahead of the June FOMC meeting. The biggest economic report will be the Consumer Price Index on Friday. While the year-over-year numbers will grab the headlines, investors will be focused mainly on the month-over-month numbers, to see if inflation is beginning to moderate.

The Cleveland Fed President Loretta Mester said she hasn’t seen evidence that inflation has peaked. “I think the Fed has shown that we’re in the process of recalibrating our policy to get inflation back down to our 2% goal. That’s the job before us,” Mester said in a live interview on CNBC’s “The Exchange. I don’t want to declare victory on inflation before I see really compelling evidence that our actions are beginning to do the work in bringing down demand in better balance with aggregate supply,” she added.

She also supports the idea of the Fed raising the Fed Funds rate 50 basis points at the next two meetings. He bias is towards hiking another 50 in September, unless economic circumstances change.

“I’m going to come into the September meeting, if I don’t see compelling evidence [that inflation is cooling], I could easily be at 50 basis points in that meeting as well,” she said. “There’s no reason we have to make the decision today. But my starting point will be do we need to do another 50 or not, have I seen compelling evidence that inflation is on the downward trajectory. Then maybe we can go 25. I’m not in that camp that we think we stop in September.”

FWIW, the Fed Funds futures have a 60% chance of another 50 basis points in September

Morning Report: Job growth remains robust

Vital Statistics:

S&P futures4,139-32.25
Oil (WTI)117.050.64
10 year government bond yield 2.97%
30 year fixed rate mortgage 5.42%

Stocks are lower this morning as investors fret about a slowing economy. Bonds and MBS are down.

The economy added 390,000 jobs in May, which was above Street expectations and the 129,000 increase ADP reported yesterday. The unemployment rate was steady at 3.6%. Average hourly earnings rose 5.2% on YOY basis. The usual suspects (leisure / hospitality and health care) increased employment, while retail fell. Retailers have been warning about consumer spending, so the number seems to fit.

Payrolls are close to pre-pandemic levels, but aren’t quite there yet.

The services economy expanded at a slower rate in May, according to the ISM Services Index. This is the lowest reading in the past year. “According to the Services PMI®, 14 industries reported growth. The composite index indicated growth for the 24th consecutive month after a two-month contraction in April and May 2020. Growth continues — albeit slower — for the services sector, which has expanded for all but two of the last 148 months. The sector’s slowdown was due to a decline in business activity and slowing supplier deliveries. The Employment Index (50.2 percent) returned to expansion territory, and the Backlog of Orders Index grew, though at a slower rate. COVID-19 continues to disrupt the services sector, as well as the war in Ukraine. Labor is still a big issue, and prices continue to increase.”

Home Prices accelerated in May, according to the Clear Capital Home Data Index. Overall prices rose 8.9% quarter-over-quarter and almost 22% YOY. The Sun Belt and Florida are the big winners, with prices in Phoenix rising 38% and Tampa rising 40%. Interestingly, the Northeast had the fastest quarterly rise. The Northeast and Midwest have lagged the rest of the market since the 2008 bust, so maybe there are some signs of life there.

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